The emerging “Lux leaks” scandal, which revealed that Luxembourg approved questionable corporate schemes to avoid tax by major companies including Ikea, Pepsi and Deutsche Bank, has two interesting dimensions.

First, it has placed tremendous pressure on Jean-Claude Juncker, the president of the European Commission, to explain and address Luxembourg’s so-called comfort letters – essentially private tax rulings – approving the intentions of 340 global companies to reduce global tax bills. The tax deals were primarily negotiated while Juncker was either finance minister or prime minister of the Grand Duchy. “While these latest revelations from the international Consortium of Investigative journalists (ICIJ) are certainly no surprise, they provide invaluable new evidence that the Luxembourg state is knowingly complicit in tax evasion on a massive scale,” said Gabi Zimmer, a German MEP and president of GUE/NGL.

Secondly, Lux Leaks raises the question of whether publicly listed companies have an obligation to minimise or avoid tax. Chief executives and boards often explain aggressive tax avoidance tactics on the basis that they are acting in the best interests of shareholders. In short, corporations do not have any legal duty to maximize shareholder value, and they certainly do not have any obligation to avoid paying tax.

The myth of shareholder value has become so entrenched that it is worthwhile examining this point country-by-country. Even in the UK, which is the most weighted in favour of shareholders of any country in the European Union, there is no requirement to maximize short-term stock price or reduce taxes. Instead, the UK Companies Act 2006 says that directors have a duty to act in good faith to “promote the success of the company for the benefit of its members as a whole” (ie shareholders), having regard to the likely long-term consequences, the interests of employees, business relationships, the community and the environment, the company’s reputation and the need to act fairly (s. 172).

In Germany, where workers have a well-entrenched voice in corporate decision-making, corporations are expected to respond to commonly accepted legal and ethical norms, and directors must consider the interests of certain parties (including employees) in addition to shareholders. Unless a business decision threatens the financial viability of the corporation, the interests are not ranked but must rather be balanced by directors. In France, directors have a duty to act in the general corporate interest of the company (intéret social), which may differ from that of the shareholders.

Where does the myth come from? Since the idea of shareholder primacy originated in the US, one might expect that a general duty to maximize shareholder value would exist there. It does not. Instead, it is an argument that can be traced back to the Nobel Prize winner Milton Friedman, who said in the 1970s that the only proper goal of business was to maximize profits for the company’s owners, meaning shareholders. Friedman was a brilliant economist but he did not understand company law. Many legal experts, including Professor Lynn Stout at Cornell Law, have shown that shareholders do not own companies and executives and directors are not their “agents”. Managers may choose to maximize share price, but they are not under any legal duty to do so. The law gives special consideration to shareholders only during takeovers and in bankruptcy. In bankruptcy, shareholders become the “residual claimants” who get what is left over.

Returning to Lux Leaks, the media furore around the companies named is perhaps one of the most compelling arguments against tax avoidance – it can cause serious reputational damage. Of course there are also arguments stemming from morality (corporations as responsible citizens) and long-term competitiveness (firms need well-funded public infrastructure and educated employees to thrive). Finally, there are financial risks for shareholders in the event that tax arrangements are subsequently challenged or ended, as may be about to happen in the EU. Since tax avoidance schemes artificially inflate net profits after tax, they can cause short-term stock price bubbles leading to subsequent unforeseen losses of share value. And that is certainly not in the interest of shareholders.

Paige Morrow is head of Brussels Operations at Frank Bold, a public interest law firm, where she specialises in corporate governance and company law. The firm leads a project connecting academics, policymakers, business and civil society to revisit the purpose of the corporation.

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Peter Burgess

There is a serious enviro-socio-economic dysfunction when almost every government on the planet is flirting with bankruptcy, and the corporate sector is awash with cash and operating with unreasonably little tax responsibility.

Posted on 11/11/14 | 4:04 PM CET

Vigor

Now Jean Claude Juncker has to take care of the EU common interest!The member states are against tax dodging!
V:B